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exam 3 (ch. 10, 11 and case study)
Terms in this set (34)
MSB vs. MPB (which curve?)
MSB = marginal social benefit
MPB = marginal private benefit
MSC vs. MPC (which curve?)
MSC = marginal social costs
MPC = marginal private costs
5 types of market failures
2. public goods
3. common resources
4. information asymmetries
5. non-competitive markets
the uncompensated impact of one person's actions on the well-being of a bystander
two types of externalities (positive and negative)
- Negative: impact on bystander is adverse (3rd party pays the cost but gets no benefits) Examples) pollution, airplane noise
- Positive: impact on bystander is beneficial (3rd party gets benefits but pays no cost) Examples) Health care, vaccines, pre-school education
when there is NO externality, then MSP and MPB, and MSC and MPC are..
MSB = MPB
MSC = MPC
when there is an externality, then MSB and MPB, and MSC and MPC are..
what is the formula for marginal social cost (MSC)
MSC = MPC + externality
supply and demand curve of a negative externality
Affects the supply curve, and quantity optimum is less than the quantity produced in market.
Overall: the market produces TOO MUCH!
MSC > MPC
supply and demand curve of a positive externality
Affects the demand curve, and quantity optimum is greater than the quantity produced in market.
Overall: the market produces TOO LITTLE!
MSB > MPB
formula for marginal social benefit (MSB)
MSB = MPB + externality
how to internalize the externality
alternate incentives so that firms/people take account of the external effects of their actions
what are the three policies on how the government can respond when an externality causes an inefficient allocation of resources?
1. command-and-control policy: regulate behavior directly (making behaviors either required or forbidden, no in between)
2. market-based policy #1: provide incentives so that private decision makers will choose to solve the problem on their own (CONTROL THE PRICE of something by using corrective tax or subsidies)
3. Market based policy #2: CONTROL THE QUANTITY (tradable pollution permits)
why do economists prefer a corrective tax?
a tax designed to encourage private decision makers to take account of the social costs that arise from a negative externality. Corrective taxes do NOT cause a reduction in total surplus, they increase economic well-being by forcing decision makers to take into account for all the resources being used, making it a more efficient way of allocating their resources.
permits vs. taxes (controlling quantity vs. controlling price)
- corrective tax: government sets the price of pollution and then firms choose the level of pollution that maximize their profit
- permits: government chooses level of pollution and firms decide what they are willing to pay for those permits
the "private solution"
problems caused from externalities can sometimes be solved by moral codes and social sanctions (when both parties try to negotiate a solution without involving the government)
the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own
what are the two different types of goods?
1. excludable: property of a good where a person can be prevented from using it (examples:
2. rival: property of a good where a person's use diminishes another people's use of that good (example: hot dog)
goods that are both rival and excludable
Private goods (examples: hot dogs, clothing)
goods that are not excludable but are rival
Common resources (examples: fish in the ocean, the environment, sheep grazing on public field)
goods that are neither excludable nor rival
Public goods (fireworks, knowledge)
problems with public goods?
there are "free riders" - someone who receives the benefit of the good but avoids paying for it. Public goods are NOT profitable, so the free market will not provide these goods
what are some solutions to the problems of public goods?
government could supply the good by sponsoring it to charge a tax that good, and the cost benefit analysis
compares the costs and benefits to society of proving a public good, how the government decides whether or not to fund a public good or not. Very difficult to measure how much someone will value a certain good.
the government will provide a good only if..
the marginal social benefit is greater than the marginal social cost.
MSB > MSC
Tragedy of the Commons
a parable that illustrates why common resources are used more than is desirable from the standpoint of society as a whole (private incentives are different than public incentives; difficult to measure that individual contribution to the overall problem, each individual has incentive to overuse good)
4 types of solutions to problems caused by externalities
1. command-and-control policy
3. pollution permits
4. Coase Theorem
what are the two issues of asymmetric information
1. Moral hazard - different incentives between the principal and agent (examples: real-estate agent, owner vs. manager of a company)
2. Adverse selection - problem that arises in markets in which the seller knows more about the good being sold than the buyer does (used-car dealer, health insurance)
what are the effects/outcome of information asymmetry?
what is market failure? (possible short answer question)
In a market failure, the market outcome is not socially optimal if left on its own. This is different from Adam Smith's theory of the "invisible hand" where he states that everyone will be better off on their own if they do what's best for them, which leads to better efficiency. However, there are some cases where markets WILL fail. Market failure usually means that there are externalities in production, public goods, common resources, etc.
What is a public good? Give an example and discuss how government can use policy to correct for the free rider problem that is associated with public goods. (possible short answer question)
A public good is a good that is neither excludable nor rival. Because it is neither excludable nor rival, free riders tend to exist, which will likely not be provided in the private market because suppliers will be unable to earn a profit from that good. To solve this issue, the government could provide the good for free such as asking for donations.
(possible short answer question) Johnny likes watching his favorite tv show on his local public tv station, but never sends money to the station when it has fundraisers? a. What is Johnny considered? b. how can the government solve the problem caused by people like Johnny? c. what are some ways the private market could solve this problem? How does cable TV change the situation?
a. Johnny is considered a "free rider"; someone who benefits from a good but avoids to pay the costs. b. What the government could do is offer this good for free. c. Private markets can create some sort of fee for profit to get the good, examples of this are markets such as Netlfix, Spotify, etc.
(possible short answer question) Is education a public good? Does it possess externalities? Can you justify having a public option for preschool or early childhood education in the United States? What are the costs and benefits of this option?
Education is NOT a public good, because it is excludable and could even be considered rival. For example, attending pre-school is optional in the U.S. However, pre-school education has a big positive externality, meaning it is difficult to measure the amount of people who benefit from it. Although, a study that could be conducted long enough over students' lifetime to testify this would show that the benefits of pre-school education do outweigh the costs which would move us closer to closing that gap in education.
what happens to public goods and common resources when the government does not intervene?
public goods will then tend to be underproduced and common resources will be overused or over-consumed.
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